Looming US Government Shutdown Stems the Dollar's Surge

Overview: The increasingly likely partial US federal government shutdown has spurred a bout of liquidation of long dollar positions. The psychologically important JPY150 level was approached, and the euro was sold through $1.05 yesterday, and the greenback has come back better offered today. It is lower against all the G10 currencies. It is mixed against the emerging market currency complex, with central European currencies and South African rand leading the advancers. The Chinese yuan has also stabilized ahead of next week's holidays. A US government shutdown is estimated to reduce GDP by 0.2% a week and will impact the data release schedule, including next week's jobs report. Moody's, the last of the big three rating agencies that gives the US a AAA rating, acknowledged that a government shutdown would be credit negative. 

At the same time, the low US oil stocks, and especially at Cushing, has seen oil prices jump, with the November WTI hitting $95 a barrel before pulling back. In the Asia Pacific, where many smaller bourses are on holiday, the large market were mixed to mostly lower. Taiwan and South Korea were notable exceptions. Note, too, that the Ministry of Finance data showed foreigners sold a record amount of Japanese equities last week and a large amount of Japanese bonds. Europe's Stoxx 600 is lower for the sixth consecutive session. US index futures are narrowly mixed. Bonds continue to sell off. European benchmark 10-year yields are 6-8 bp higher, while the Gilt yield is up 10 bp. The 10-year US Treasury yield is up two basis points to 4.63%. A softer US dollar and higher rates leaves gold pinned near yesterday's low (~$1872).

Asia Pacific

In the eight weeks since the Bank of Japan adjusted Yield Curve Control at the end of July, Japanese investors have been net buyers of about JPY6 trillion or around $41 bln of foreign bonds. The threat of further yen depreciation offsets the less than 30 bp increase in the 30-year yield since the 10-year yield cap was lifted to 1.0%. On the face of it, this suggests that unlike last year, when Japanese investors were divesting from global bonds, they are not driving the rise in G10 yields. Moreover, the US TIC data shows Japan's holdings of US Treasuries have risen by about $37 bln this year, a small re-accumulation after last year's slide (includes valuation) of about $225 bln. Since the end of 2019, before Covid, Japanese Treasury holdings (including valuation) have fallen by about $33 bln. Meanwhile, foreign investors have been net sellers of Japanese bonds for the three months through August. They appeared to return to the buy side this month but last week sold JPY 2 trillion, the most since January. On the equity side, Japanese investors have been net sellers of foreign equities for four months through August but here in September have also returned to the buy side. The yen's continued decline may encourage the return of international markets. After selling the most Japanese equities in four years in the week ending September 15, foreign investors sold JPY3 trillion of Japanese equities, a new record, in the week that ended September 22. Separately, note that ahead of the weekend, Japan is expected to report slower Tokyo CPI, a small decline in unemployment, and a modest rise in retail sales after the heady 2.2% increase in July, the most since mid-2020.

The dollar reached JPY149.70 yesterday but the market has drawn cautious, and the greenback is inside yesterday's ranges. Ramped up intervention fears, as the JPY150 level is approached, and the risk of a US government shutdown has steadied the market. Support is seen in the JPY148.80-JPY149.00 area. The Australian dollar is firmer but inside yesterday's range when it fell to a new low for the year (~$0.6330). It has reached about $0.6380 today and faces resistance in the $0.6400-15 area. The PBOC set the dollar's reference rate slightly higher today at CNY7.1798, but the gap with the Bloomberg survey average (CNY7.3224) was a new extreme. China's markets are closed next week for the Golden Week holidays. The greenback is consolidating in the well-worn recent range. 

Europe

Attention turns to eurozone inflation. Germany and Spain reported their figures ahead of the aggregate report tomorrow. German states have already reported, and the national CPI is due shortly. The EU harmonized measure is expected to rise by 0.3%. Due to the base effect, where last September Germany's CPI surged by 2.2% (followed by a 1.1% gain in October), the year-over-year rate is expected to fall to 4.5%-4.6% from 6.4%. Another decline is expected next month, which could put it closer to 4%. Still, additional progress may be difficult to achieve in the last two months of the year. A 0.3% increase in September would translate into a 4.8% annualized rate in Q3, up from 3.2% in Q2 and a little more than 10% in Q1. 

Spain did not have the inflation surge that Germany did last September and October. Indeed, last September Spain's EU harmonized measure fell by 0.2% and rose 0.1% in October. The 0.6% increase reported earlier today translates to a 4% annualized rate in Q3, the same as in Q2 (and 6.4% in Q1). The year-over-year increase peaked in July 2022 at 10.7% and in June 2023 had fallen to 1.6%. It has steadily risen since and reached 3.2% this month and is expected to rise next month as well, owing primarily to rising energy and fuel costs. The core measure eased to 5.8% from 6.1%, which was lower than economists anticipated. The eurozone aggregate figures are expected to show a 0.5% month-over-month increase, which is consistent with the year-over-year rate moderating to 4.5% from 5.2%. Next month it could fall below 4%. The core rate is seen falling to 4.8% this month after 5.3% in August. At an annualized pace, given a 0.5% increase this month, EMU's inflation is running at a 3.6% clip in Q3 the same as in Q2.

The euro slipped slightly below $1.0490 yesterday but has steadied today and reached a little above $1.0540 in the European morning. The break of $1.05 seems like some kind of catharsis and the markets attention appears to be shifting to the implications for US rates and the economy of the increasingly likely partial US government shutdown and the expansion of the autoworkers strike tomorrow. Resistance is seen near $1.0575, yesterday's high. Sterling reached almost $1.2110 yesterday but has bounced back smartly through yesterday's high (~$1.2165) and has resurfaced above $1.2200 in the European morning. The five-day moving average is near $1.2190, and sterling has not closed above it in about 2 1/2 weeks. A close above $1.2220 could lift the technical tone.

America

The revisions to Q2 US GDP are inconsequential as Q3 draws to a close. The latest monthly survey by Bloomberg found the median economist forecast for Q3 growth rose to 3.0% from 1.8% previously. If accurate, that would be the strongest since Q3 22, despite the tightening of credit and the rise of interest rates. The Atlanta Fed's GDP tracker is at 4.9%, u unchanged from the previous week. Elsewhere, weekly jobless claims are expected to pop back after last week's surprise decline to 201k, the lowest since the end of January. Moreover, the real signal from the labor market is that job growth is slowing, and this seems the most likely signal from next week's nonfarm payroll report (which may not be available if the federal government partially shutdowns for lack of spending authorization). Meanwhile, rising rates and continued weakness in the housing market warns of softer pending home sales. Tomorrow's personal income and consumption data, inventory and trade reports are more important data points. The PCE deflator may draw most attention, but the CPI captured the signal:  the headline is likely lifted by energy while the core rate likely eased. A 0.5% increase in the headline deflator translates into a 3.6% annualized rate over the three months through August, up from 2% in the previous three-month period. A 0.2% increase in the core deflator puts the three-month annualized rate at about 2.5%, down from nearly 3.7% in the previous three months.

Mexico's central bank meets later today. There is practically no chance of a change in the overnight rate target of 11.25%. The economy is resilient, and inflation is slowly moderating. The central bank has signaled to the market its intention on keeping the policy rate at elevated levels for a protracted period. Previously, the swaps market seemed to favor a cut late this year, but it has been pushed back into Q2 24. Yesterday, Mexico posted a somewhat larger than expected trade deficit (~$1.38 bln) as both imports and exports by more than 10%. In August, on a year-over-year basis, exports are up 3.75%, while imports have risen by 4.3%. In the first eight months of the year, the trade deficit has average $1.075 bln a month, down from $3.09 bln average in the Jan-Aug 2022 period. In Brazil, minutes from the recent central bank meeting temper and comments from Governor Neto have tempered hopes for more aggressive rate cuts. Still, the irrepressible dollar pushed it its best level against the real since the end of May (~BRL5.0175). The central bank signaled 50 bp cuts are likely through next May. If delivered, it would bring the Selic rate to 10.50%. Brazil, Chile, Peru, Uruguay, and Paraguay have all begun an easing cycle. 

The US dollar peaked against the Canadian dollar yesterday near CAD1.3545, just shy of the 20-day moving average. It reversed lower and follow-through selling has taken the greenback to about CAD1.3480 today. Nearby support may be seen in the CAD1.3450-60 area. In the surge yesterday, the US dollar reached almost MXN17.8170, slightly shy of the 200-day moving average (~MXN17.85). Peso buyers emerged and sent the dollar lower, and some additional sales today has knocked it back slightly below MXN17.65. Support is seen near MXN17.50.

Disclaimer